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Starwood Hotels & Resorts Worldwide Inc. (NYSE:HOT)

Q2 2007 Earnings Call

August 2, 2007 10:30 am ET

Executives

Jay Koval - VP of IR

Bruce Duncan - Chairman of the Board & Interim CEO

Vasant Prabhu - CFO

Analysts

Celeste Brown - Morgan Stanley

Joseph Greff - Bear Stearns

Bill Crow - Raymond James

Harry Curtis - J.P. Morgan

William Truelove - UBS

Jeff Randall - A. G. Edwards

Steven Kent - Goldman Sachs

Won Kim - JMP Securities

Sule Laypan - Lehman Brothers

Joseph Greff - Bear Stearns

Presentation

Operator

Good day and welcome to the Starwood Hotels & Resorts' Second Quarter 2007 Results Conference Call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the conference over the Vice President of Investor Relations, Mr. Jay Koval. Please go ahead, sir.

Jay Koval

Thank you, Terry, and good morning everyone. I would like to thank all of you for joining us for Starwood's second quarter 2007 earnings call. Joining me today, I have Bruce Duncan, Chairman of the Board, Interim CEO and Vasant Prabhu our CFO.

We will be making statements on this call related to company plans, prospects, and expectations that constitute forward-looking statements under the Safe Harbor provision of the Securities Reform Act of 1995. These forward-looking statements generally can be identified by phrases such as Starwood or its management believes, expects, anticipates, foresees forecasts, estimates, or other words or phrases of similar import. All such statements are based on our expectations as of today and should not be relied upon as representing our expectations as of any subsequent date.

Actual results might differ from our discussion today. I point you to our 10-K and other SEC filings available from the SEC or through our offices here and on our website, at starwoodhotels.com for some of the factors that could cause results to differ.

With that, I would like to turn the call over to Bruce for his comments.

Bruce Duncan

Thank you, Jay and good morning. As you’ve all seen by now from our press release, Starwood reported excellent second quarter results, delivering earning per share of $0.82 and generating $362 million in EBITDA. After adjusting for the joint venture gains and the lower than expected tax-rate in the quarter, we still are consensus views in our guidance.

Worldwide business fundamentals remain sound, and we continue to believe Starwood’s gross prospects remain bright as we are starting to see our pipeline translated in the strong unit additions to the system. Worldwide system-wide REVPAR increased 10.2% in the quarter, with outstanding results across each of our international regions.

Europe gained 12.8%, Africa and the Middle East jumped 15.7%, Asia Pacific increased 12.8% and Latin America grew at 9.8%. Company operated international results were even better, rising 14.6% in the quarter or 9.3% excluding the impact of foreign exchange. Worldwide branded own REVPAR increased 10.4% in the quarter, with international owned results up 17.7%, and North American owned REVPAR up 6.1%.

While, we believe these are terrific results, its worth noting that our global diversified lines of business allowed Starwood to deliver excellent results, despite North American owned results that came in at the low-end of our guidance. As this business, now accounts for just 20% of total company profits.

Worldwide margins improved to 148 basis points in the quarter. Our Fee business continues its impressive growth with management and franchised up 13.8%.

REVPAR growth is solid, margins are improving, and we are seeing strong net additions to our system. In the second quarter, we added 26 hotels to our system; net room additions totaled over 6000 rooms, 95% of which were in the upper upscale and luxury segments. Our pipeline continues to lead the upper upscale and luxury segments according to Smith Travel Data. And we now have over 440 hotels and 105,000 rooms in the active pipeline.

Our pipeline is robust and growing, as developers continue to turn the Starwood's brands for their hotel projects. Our brand teams continue to lengthen our lead over the complication by creating differentiated experiences, that are new, better, and special, all of which help drive consumer preference which in turn drives developer demand.

The Company remained highly focused on Sheraton and the brand team continued its work in the quarter. The owner advisory board met again in Toronto last month to review the six key initiatives that we believe should be the most meaningful impact in the hotels in terms of GSI scores, REVPAR gains and overall profitability. These initiatives include redesigned guest rooms, additional club floor space, the parks, environment in the lobby, and improved fitness facilities, and food and beverage offerings. Owners were supportive and enthusiastic about the plans and we began work on a Sheraton New York and expect to begin work in the Sheraton Chicago later this quarter.

Westin has a leading position in the upper upscale segment today, and continues to innovate around personal, instinctive renewal. The brand just launched a new campaign on trains and subways to surround commuters with Westin's messaging around this is how it should feel.

We opened several new hotels in major urban U.S. markets, such as Washington D.C., San Francisco, and San Diego. And our new international hotels in Guangzhou, China and Auckland, New Zealand; demonstrates the worldwide demand for the Westin brand.

The Le Meridien, team unveiled a new model at the NYU conference in June, and that was well received by developers and owners. The model room will be rolled out in new build projects and included in San Francisco's current renovation program. The Le Meridien hotel continues thrive under the Starwood system and enjoyed REVPAR increases of 15.7% in the quarter. The new initiatives such as elevated experience and unlock hours should help ensure that this growth continues.

The luxury group continues to improve the service and quality of the guest experiences at each of the group's brands. St. Regis has now hosted over 30 events for VIPs under its Aficionado program including dinner with [George] at the Auckland Food and Wine Festival.

Storage service culture training is well underway at the luxury collection. And new property guides and a redesigned website will be launched early next year to better showcase the quality and uniqueness of the luxury collections hotel offerings.

And W continues to be one of the most sought after luxury brands in the hospitality industry today with well over 12,000 rooms in the active pipeline. Consumer demand for the brand remained strong and developers around the world are turning to W for their luxury projects in major urban and resort markets.

The Four Points team continues its campaign around honest uncomplicated comforts and it's resonating with guests, evidenced by improved J.D. Power rankings and GSI scores, which is translating into strong developer interest for the brand. In fact Four Points pipeline has more than doubled in the past year to well over 10,000 rooms.

We also continue to see strong developer interest in our Select-Serve and Extended-Stay offering. As they breath new life into segments that were dull and boring, in fact at quarter end we had well over 100 hotels in the worldwide pipeline between the two brands and we expect to open our first property next spring.

Our vacation ownership business enjoyed strong reported results due to percentage of completion accounting. While originated sales were up only 2.7% in the quarter new projects are selling well and despite some delays on a few projects, which Vasant will discuss at greater length, we remain confident that the underlying fundamentals in this business remain strong.

Now let's turn to our outlook for the rest of the year. Our guidance on a worldwide basis for company operated worldwide REVPAR growth of 8% to 10% is unchanged from prior expectations. With second quarter North American owned results coming in at the low end of our range. We are nearing our guidance for North American owned REVPAR to be up 7% to 8% for the full year. This guidance is consistent with the comments we made on our last call regarding the REVPAR ranges.

The supply picture in the upper-upscale and luxury segments and in the major urban markets remains favorable relative to historic levels of growth and we expect this to continue for several more years. Our brands are in great shape and should continue to drive additional pipeline growth that will help power our managing franchise business well into the future.

To summarize, business fundamentals remain strong and we are successfully executing on the strategy that is just beginning to deliver the long-term growth that will create value for our shareholders for many years to come. We bought back over $470 million of stock in the quarter and we continue to see good value in our stock, relative to our long-term growth prospects. And we remain committed to returning cash to you through additional share repurchases over the course of the year as we work towards our targeted ratios.

With a strong global platform, world class bands and unparalleled portfolio of own hotels, a best in class vacation ownership business and the strongest pipeline in the industry. We believe that Starwood is well position to provide industry leading results over the long-term. Our strategy is set and we have 145,000 very talented and dedicated associates around the world who are focused on executing our business plan. And I would like to thank them for all their great work.

That concludes my prepared remarks. But before I turn the call over to Vasant, let me briefly address one question, I am sure many of you have. Which is, what is the status of the CEO search? We are obviously limited to what we can disclose at this point, but what we can say is the following. The search is going well, we are now entering the final stages as what has been a very productive process and we expect to be able to make an announcement in the current quarter. And that’s where we need to leave it for today.

With that, let me turn over the call to Vasant, for more details on the financials and our guidance.

Vasant Prabhu

Thank you Bruce and good morning everyone. Our global portfolio of strong hotel brands and vacation ownership resorts delivered another quarter of industry leading results, despite some softer than expected top-line trends in the U.S. Today I’ll focus on two topics, our pipeline of hotels and our outlook for the balance of year along with a couple of items related to 2008.

At the end of the quarter, we had approximately 440 hotels in our global pipeline, representing around 105,000 rooms. We expect substantially all of these hotels will open before the end of 2010. Relative to the 888 hotels and 273,000 rooms we currently have in our system, this represents significant system growth over the coming years. Helped by the power of our brands, our global platform, and a relative under-penetration in the US, we are well positioned to deliver the highest fee growth in our sector, as our hotel opening accelerate particularly in to 2009 and 2010.

Not only is our pipeline one of the largest in our sector, it is by farther highest quality pipeline, with all our 70% of the rooms in the upper upscale and luxury segment. These hotels as you know are larger and command higher room rates. As such the fees derived per hotel are many times higher on average, than fees on a typical select-serve hotel. Half of our pipeline is outside North America, expanding our leadership of the four and five star segments in high growth international markets.

In China for example, we currently have 34 hotels in operation with 45 more in the pipeline. We expect that by 2010, we will have over 80 hotels in china extending our lead as the largest operator of five star hotels in this market with all our majors brands represented.

In India, we have the largest presence among the international lodging companies in the five star category; with 19 opened and another 25 in our pipeline. We expect to have well over 40 high-end hotels in India by 2010. In both China and India, we are discussing major launches of our select-serve brand through joint ventures with large local developers. And another fast growing region, the Middle East, we currently have a commanding lead in high-end hotels, with 67 opened and 22 in the pipeline, which would mean Starwood has almost 90 hotels in the Middle East by 2010. REVPAR growth as you know in most international markets is accelerating both in local currency terms and of course in dollars.

With half of our fees already derived from markets outside the U.S, we remained focused on capturing the large high growth and very profitable international opportunity. The Starwood organization is single mindedly focused on getting our pipeline of hotels open, and opened hot as we like to say. From 60 hotel openings in 2006, to an anticipated 80 opening this year and over a 100 next year. Hotel openings are accelerating sequentially year-over-year. We will have a commensurate acceleration in our fee growth particularly in 2009 and 2010.

Moving on to our outlook for the balance of 2007, in our owned hotel business globally in Q2 we had 10.4% REVPAR growth, and almost 150 basis points of margin improvement. Although U.S. hotels were at the low end of our guidance range, this was offset by strong international growth with great flow through and margin improvement. As expected North American owned hotel results are heavily impacted in the third quarter by renovations at three major hotels. Renovation impact in the third quarter is over 150 basis points on REVPAR and over 70 basis points on margins.

One of these renovations is running behind schedule, so the impact is a little higher than previously anticipated. The third quarter is also impacted by both Jewish holidays following in the month of September, but as you know from others in our sector, our group pace looks very good as we move into Q4 and 2008.

Our international owned hotels, we expect the strong growth to continue in the third quarter with REVPAR growth in the mid-teens and margin improvement well over 200 basis points. As a reminder, international hotels represent almost 40% of our owned EBITDA. Expectations for growth in our Fee business remain unchanged.

In our vacation ownership business originated sales growth is strong in Orlando and our project in Cancun is also selling very well. We expected originated sales trends to pick up in Hawaii, as new owners were among some of our best customers for additional weeks, take possession of their units in the second phase of our Maui project which opens in July.

SVO remains on track to deliver as per expectations in 2007. However, SVO has experienced some delays on new projects in Aruba, the next phase at the western Maui and the Sheraton Kauai. As a result sales and construction starts are later than previously anticipated for these projects. We have received all necessary approvals in Aruba at this point and the project is moving ahead. We're also making good progress in both Maui and Kauai.

We expect to receive all necessary approvals in Maui and start the project in the second half of 2008 with Kauai starting in 2009. However, all these projects will not be as far a long as previously anticipated on the percentage of completion basis by the end of 2008. As a result of these delays we expect that SVO reported profits could decline by as much as a $125 million in 2008, versus where they will end up in 2007. Since these projects are moving ahead and will be completed these projects will be recognized with a 12 month to 24 month delay, versus prior expectations.

Business fundamentals in the vacation ownership business in terms of tour flow, close rates and pricing remain healthy for projects currently in sales. And 2009 profits at SVO should be up sharply and in line with prior guidance. While it is too early to provide 2008 guidance, given the significant impact on 2008 of the SVO delays, we wanted you to have this information.

Also, adjusting our 2007 EBITDA for non-recurring item like JV gains, the full impact of the asset sales previously announced as well as hotel shutdown for redevelopment, including Bal Harbour and two hotels we will make into a lot. Our forecasted EBITDA from continuing operations for 2007 is roughly $1.3 billion. As has been our practice, we will provide a preliminary guidance range for 2008 in October, when we report our Q3 results.

So in summary, our global portfolio is delivering as expected, our brands remain highly attractive to owners and developers and we remain in single-mindedly focused on executing our strategy.

With that, I’ll turn this back to Jay.

Jay Koval

Thanks Vasant. Now its time for our Q&A. So in the interest of time and fairness, please limit yourselves to one question at a time and then we’ll take any of your follow-up questions as time permits. Terry, we are ready for the first question, please.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we go to Celeste Brown, Morgan Stanley.

Celeste Brown - Morgan Stanley

Hi guys, good morning.

Bruce Duncan

Good morning.

Celeste Brown - Morgan Stanley

Are you seeing, I mean your pipeline continued to grow in the quarter, but are you seeing any reluctance on the part of developers with say the question about the future, the CFO in the future. Are they continuing to sign up as you would have [effect]?

Bruce Duncan

They are continuing, we probably in the first half I think we signed up about 98 new hotels, our budgets for the year is we can sign up close to 200. So we are on target there hasn’t been any hesitation.

Operator

And we'll go next to Joseph Greff, Bear Stearns.

Joseph Greff - Bear Stearns

Good morning, guys. Vasant I was hopping you can give us an update on the assets sales, I know the last quarter you talked about marketing 13 ounce and 8 ounce consolidated joint ventures with proceeds somewhere around $500 million and maybe you could also in the context of answer that question kind of talk about why you aren’t supporting auctions for the Sheraton Manhattan? Thank you.

Vasant Prabhu

Sure, the assets sales are on track, most of the sales completed so far some of those smaller hotels. We expect to make what we had an indicated earlier the process is well underway for the remaining hotels, there will be more closes in Q3 and the rest in Q4. So nothing fundamentally has changed on that front. On the Sheraton Manhattan we are well in to the marketing process, there has been huge amount of interest, large quantities of confidentiality agreements have been signed. So the process is well underway and we are expecting at least first round a bids sometime later in the summer and it will proceed from there.

Jay Koval

Next question please.

Operator

We'll go next to Bill Crow, Raymond James.

Bill Crow - Raymond James

Good morning. Vasant, can you just clarify the timeshare discussion you were just having. Is that $120 million pretax impact EPS related to earnings or is that a revenue number?

Vasant Prabhu

No, that’s an earnings number, it's an EBITDA number, its $125 million that is our current estimate of how much lower our timeshare numbers are likely to be versus this year's profits next year. And as I said earlier it's due to these delays and as you know if you are at a different percentage of completion at the end of '08 then where you might have expected you will see the impact on your reported earnings, it moves out into future years so we would expect '09 to be back up again in the ranges we thought earlier, but this all moves things out 12 to 24 months.

Jay Koval

Next question please.

Operator

We will go next to Harry Curtis, J. P. Morgan.

Harry Curtis - J. P. Morgan

Hi, good morning. Could you comment on your policy that you are operating under with respect that communicating bids or indications of interest in acquisitions of Starwood. And is there any obligation or legal obligation that the Board is under to communicate any interest of indications of interest to the shareholders?

Bruce Duncan

Harry, Starwood has a long-standing policy of varied comment on rumors and speculations in the marketplace. And we have armies of lawyers that we had any obligation I am sure they would tells us that.

Jay Koval

Next question please.

Operator

We will go next to William Truelove, UBS.

William Truelove - UBS

Hi guys. In the current market conditions is going to make it more difficult to sell your timeshare notes and is the timing for the timeshare sale notes is still roughly in the fourth quarter this quarter?

Vasant Prabhu

Yeah, we are still planning to sell the timeshare notes in the fourth quarter. As you know we don’t have to sell them in the fourth quarter. If market conditions are not ideal, we will make the right business decision in terms of whether this is a right time to sell it or not. Typically we do it towards the later part of the quarter. We will monitor the situation, it’s a fairly standard and well understood product, and we are not anticipating at this time that there should be any problems, but we will make what we think is the right business decision. So, we are not going to go out and sell them if we think the market conditions won't get us the best pricing.

Jay Koval

Next question please.

Operator

We will go next to Jeff Randall with A. G. Edwards.

Jeff Randall - A. G. Edwards

Hi, good morning. I just wondered if you guys could remind us of what timeframe is represented by the 440 hotels in the pipeline? And then secondly on the timeshare the $125 million decline in EBITDA, does that contemplate, I mean you talk about pushing it out 12 months to 24 months, but does that contemplate a decline in margins given that presumably your cost are going to be higher for those units?

Vasant Prabhu

Yeah. I'll answer the timeshare question first, as you know how the debate works in percentage of completion accounting under the new accounting rules, is that the new rule that went in for time share accounting is that in the early stages of a project you are expensing a lot more than you use to under the old rules. So, typically what do you see in the project is that margins are very low in the early stages of the project, and they get to be very high in the later stages of the project.

So, given that these projects are delayed what you should assume is that, they will be in their early stages in '08 relative to what might have been expected. And as a result of being in their early stages, the margins on these projects will be very low and in fact some of these projects lose money in the first few months, because the expenses are much higher than any revenue you can recognize. So, yes it will have an impact on margins but that all plays itself out as the projects are completed, so that is part of the reason that there will be that decline.

Bruce Duncan

On the 440 hotels are in the pipeline, we anticipate most and all of those would be completed by 2010 with the bulk in 2009 and 2010. Again next year we anticipate to have a 100 hotels opening.

Jay Koval

Next question please.

Operator

We go to Steven Kent, Goldman Sachs.

Steven Kent - Goldman Sachs

Hi good morning. Could you just go through what your EBITDA would be in constant dollars acknowledging that your revenues and expenses are on a local basis, but when you translate back what percentage of either growth rate or what the dollar amount would be in constant? And in that same light Bruce I think you said North America is only 20% of EBITDA, you are only talking about your management fees and franchise fees a 20% of overall from North America?

Vasant Prabhu

Well, what Bruce was referring to is a North American owned EBITDA, it is about 20% of our total EBITDA, so that’s what he was referring to.

Steven Kent - Goldman Sachs

So then overall what’s North America then Vasant?

Vasant Prabhu

North America on the Fee business side is about 50% and on the owned hotel side is a little over 60%. So, on a total business basis is a little over 50%, on the hotel business. And then of course there is a timeshare business. So, in the hotel business, North America is a little over 50% in total.

And then your other question was, the impact on EBITDA FOREX, I don’t have a number handy in terms of what the dollar impact of FOREX on EBITDA was but you did hear in Bruce’s comments that on the international side the company operated hotels, the margin was about 500 basis points of reduction in REVPAR. So, on the global basis it probably had somewhere between 100 basis points and 150 basis points impact on REVPAR. I couldn’t give you what the specific impact of FOREX on EBITDA is.

Jay Koval

Next question please.

Operator

We go next to [Won Kim] JMP Securities.

Won Kim - JMP Securities

Good morning guys. Hi, can you talk about a little about the softness that you saw in North American REVPAR specifically?

Bruce Duncan

We weren’t able to hear the question, can you repeat the question?

Won Kim - JMP Securities

Sorry about that. Good morning. Can you talk a little bit about the softness that you guys saw in North American REVPAR specifically, looks like you saw some occupancy weakness in other hotels as well as your luxury collection?

Vasant Prabhu

Yeah, obviously the system wide results represent a variety of factors, if you look at our numbers versus what our competition, there are differences in terms of footprint and there are differences in terms of what might be going on in the system. So, if you look at Westin for example it is affected by some hotels, its not as larger system as some of the other systems in the US.

So, a couple of markets can affect it, so we did have sort of softish conditions in some large markets like Atlanta, where there is a big Westin. We also had a couple of big renovations going on, we had a couple of large Westin, the Moana Surfrider in Hawaii and The Westin Galleria in Dallas under renovation. Those are large hotels in the systems, so those hotels by themselves had about a 100 basis point impact in REVPAR on the Westin system.

In the case of Sheraton, we have been working very hard on getting owners to upgrade their Sheraton's and they have been very aggressive and getting them to put money in to the system. There is more hotel rooms under renovation in the Sheraton system today, especially on the franchise side then they were last year. So, in fact if you looked at our numbers if the franchise side of Sheraton that pulled down the REVPAR for the brand.

There are also couple of large hotels on the managed side in Sheraton. So, renovations and the footprint can explain some modest differences. Our market share as best we know as reported by Smith Travel was actually up in the quarter, so we feel things that in fact in good shape.

Jay Koval

Next question please?

Operator

We'll go to Sule Laypan, Lehman Brothers.

Sule Laypan - Lehman Brothers

Good morning, I actually wanted to circle back to the assets sales, I think, you had originally guided that, there would be turn by the first half and I was just wondering what was the reason behind the timing been pushed out? Thanks.

Vasant Prabhu

Yeah, you know you make a best estimate in terms of when things will get done, and we definitely want to get the best prices and we want to make sure that we hold out for the best terms. So, sometime these things drag out a little longer than you expected there is nothing fundamentally different. We set a goal of trying to get it all done at may be year or so, it's extending a little further out, but the sales are well under way, and they will get done at the levels that we indicated they would get done. So, we are not expecting anything different.

Jay Koval

Next question please.

Operator

(Operator Instructions) And we will go to Celeste Brown with a follow-up question.

Celeste Brown - Morgan Stanley

Hi. Sorry, I'll take myself out of the queue, sorry.

Jay Koval

Next question please.

Operator

We will go to William Truelove with UBS

William Truelove - UBS

Hi, guys. My follow-up question is about share repurchases. Do you guys have an automatic program sort of in place in terms of may be numbers of shares or in terms of dollar amounts given that the share prices come back so much. Would it be more shares that would be repurchased? And where do you stand relative to your share repurchase authorization? Thanks.

Bruce Duncan

I think our authorization, at the end of the quarter; we still had about $700 million outstanding under debt, and I would think you should anticipate that we think our stock is of very good value, and we will continue to be aggressive purchasers out there.

Jay Koval

Next question please.

Operator

We will go next to Joseph Greff with Bear Stearns for a follow-up.

Joseph Greff - Bear Stearns

Just a question on the full year 2007 guidance. What you have contemplated in there from earnings contributions from unconsolidated joint venture hotels? And then as you kind of look at through that adjusted EBITDA number, how much of that stuff comes out related to selling some of those joint venture interests?

Vasant Prabhu

Most of the joint venture interest that we had planned to sell are pretty much sold at this point, so the bulk of that impact should be reflected in our back half numbers. In terms of what is our specific forecast for balance is here on the joint venture numbers, I don't have it in front of me but after this we can talk to you and help you with that.

Jay Koval

Operator are there any additional questions.

Operator

We do have another question from Harry Curtis, J.P. Morgan.

Harry Curtis - J.P. Morgan

Hey, I just wanted to go back to the second quarter REVPAR domestically and am I correct in estimating that when you back out the three hotels that are being renovated that the rest of the North American system was up around 6% to 6.5%?

Vasant Prabhu

Actually high than that I mean the impact on the owned hotels with the renovations was 110 basis points on REVPAR, so the rest of the owned hotels would have been up more like 7.2%.

Harry Curtis - J.P. Morgan

7.2%.

Vasant Prabhu

And the margin impact was slightly over 40 basis points so we've made a little over a 100 basis points in margin improvement without the renovation impact.

Harry Curtis - J.P. Morgan

Okay, good. Thank you.

Jay Koval

Well that wraps up our second quarter call. Please feel free to contact us if you have any additional questions and we appreciate your time and interest in Starwood Hotels & Resorts. Good bye.

Operator

That concludes today's teleconference. Thank you for your participation.

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